ASI: Emerging markets should seize reform

ASI: Emerging markets should seize reform

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By Jeremy Lawson, Chief Economist, Aberdeen Standard Investments

Most emerging and developing economies aim to close the gap in living standards with developed markets. The withering impact of the pandemic on many emerging economies makes the case for reform in these countries all the more urgent. They all have options. It all comes down to whether policymakers take them.

The scale of the catch up effort should not be underestimated. China is the economic poster child for rapid convergence. Its growth of 8% a year per capita over the past 40 years has been much stronger than any other emerging economy, and five times greater than the US. And yet the level of per capita incomes in China remain two thirds below American levels.

The pandemic has made the task of emerging economies even harder. Vaccination roll outs are faltering (partly because developed markets are hoarding them) and India and Brazil – two of the biggest emerging economies – are tragically also amongst the worst impacted. The result is that the path out of the pandemic for the typical EMDE is looking more arduous than in much of the developed world.

Excluding China, which has navigated the pandemic better than almost anyone else, economic output in the Asia and Pacific Rim countries was still almost 7% below pre-Covid levels at the end of last year. In Latin America and large parts of Africa the gap was even larger. For developed market economies, that gap in output is barely 5% and they are closing it more quickly.

More worryingly this risks becoming more than just a cyclical problem. The World Bank predicts that in the aggregate, emerging economies will suffer almost twice as much long-term economic damage from the COVID pandemic than the developed economies. In their view private investment is likely to be hindered by sustained uncertainty and risk aversion. And public investment is likely to be curtailed by a more rapid reversal of Covid-related fiscal support.

But forecasts are not destiny. There is a real opportunity for emerging countries to change this narrative by pursuing structural reforms that will boost growth. In particular they can act to accelerate the two secular themes that will dominate the economic landscape over the next 30 years and beyond: digitization and decarbonization.

It will not be easy. Even before the pandemic, growth in emerging economies was decelerating. The World Bank estimates potential growth fell to 4.4% in the second half of the 2010s from 5.6% in the first decade of the century. This was predominantly due to slower labour productivity growth, itself a function of stalling reform momentum.

That assessment may be too pessimistic though. Emerging economies are actually well placed to make huge progress on both digitization and decarbonization, if they seize the reform initiative.

This is partly because they do not have the legacy of replacing infrastructure that was built for an analogue and fossil fuel intensive world as many developed markets do. Take banking for instance, rapid transition to mobile payments is easier when physical banking infrastructure is already limited.

Equally, adapting electricity grids to renewable generation is easier when those grids are already underdeveloped and in need of new investment.

There is also much more low hanging fruit in emerging economies. It is a truism that poorer countries tend to have weaker economic and political institutions.

But this is also an opportunity. Reducing red tape in decision making and approval, increasing the quality and transparency of decision making, and strengthening competition policy all cost little, but can have very large payoffs.

The World Bank estimates that implementing a menu of reforms to governance and doing business could lift emerging market growth by 0.9 percentage points per year over the next decade.

Meanwhile a combination of formal carbon pricing and a pivot towards green infrastructure spending, would boost the speed of the recovery from the pandemic, lift long-term potential growth, and help meet the net zero goals that are vital to avoid even more damaging climate change.

This opportunity set is admittedly harder to pin down. But they are there all the same. The World Bank identified more than 500 reform advances related to improved governance across certain emerging markets between 2006 and 2020. And while there were notable setbacks as well, the breadth and impact of those reform attempts shows what can be done.

The biggest obstacles to emerging markets levelling up are ones within the control of their governments. Whether they take the opportunity remains to be seen but the ball is in their court.